Title :- Analyzing the Impact of Regulatory

Changes on the Rise and Fall of Interest Rate

Futures in the Indian Derivative Market.

Abstract:
The Indian derivative market has witnessed significant
fluctuations in interest rate futures, influenced not only by
market forces but also by regulatory changes implemented
over the years. This topic aims to comprehensively analyze
the impact of regulatory modifications on the rise and fall of
interest rate futures in the Indian derivative market. By
conducting an in-depth examination of specific regulatory
policies, their objectives, and corresponding market
responses, this study seeks to shed light on the intricate
relationship between regulatory interventions and market
dynamics.

1.Introduction :-

Equity derivatives, interest rate derivatives, commodity

derivatives, foreign exchange derivatives, and credit
derivatives are the derivative products available all over the
world. From all types of derivatives, interest rate derivative is
regarded as the most popular product and interest rate
derivative market is the largest derivative market in World.
Frankel (1984) mentioned interest rate futures as an
innovation in financial techniques for the management of risk.
Morris (1989) found greater volatility in the returns of bond
create risk to the bond holders. Interest rate futures (IRFs)
help the investors to protect their bond return by providing a
hedge against interest rate changes.
In the international market, interest rate derivatives are the
most traded and commonly recognized derivative instrument.
However, this commodity is not well-known in the Indian
derivatives market. In 1999, the Over the Counter (OTC)
Interest rate derivatives on the open market (OTC) were
launched and profitable in terms of volume. India's financial
market in the year established exchange traded interest rate
derivatives 2003, 2009 and 2014.

1.1 Background of the Study:

Long term (10 years and beyond) and short term (up to one
year) interest rate futures are the two forms of interest rate
futures available internationally. Long bond futures are long
term futures, whereas treasury bill futures and reference rate
futures are short term futures. Long-term bond futures
markets throughout the world are both physically and cash
settled.
 For example, the Chicago Board of Trade (CBOT) futures on
the 10-year municipal bond index are cash settled. T-Bill
futures are physically settled, but futures on reference rates
such as London Inter-Bank Offer Rates (LIBOR) are cash
settled (Bansal, BSE).

1.2 IRFs in Indian Scenario:

In India, there are two types of debt markets: sovereign

(government) debt markets and corporate debt markets.
Government bonds are more popular than corporate bonds
since the risk of default is quite low. In the more developed
markets, interest rate futures are commonly used. In order to
reap the benefits of IRFs, the RBI established OTC interest
rate derivatives in 1999. Interest rate swaps (IRS) and forward
rate agreements (FRA) were two OTC IRFs announced in
1999. In 2003, 2009, and 2014, exchange traded IRFs were
established.
Interest rate derivatives in India are presented in Table 1.
Table 1: Interest Rate Derivatives in India.
Year Products Stock Exchange Participants Trading Hour
1999 FRA These are purely OTC instruments Scheduled Commercial Banks (Excluding
and are not allowed to trade in Regional Rural Banks), Primary Dealers
Exchanges. (PDs) and all Indian Financial Institutions --------------
(FIs)

IRS

June 2003 10 years NSE Primary Dealers (PDs). Banks are Barred 9AM to 5PM
Govt. of from holding trading position in IRF Mon to Fri
India Bonds
Aug 2009 10 years NSE & BSE All Scheduled Commercial Banks, Primary 9AM to 5PM
Govt. of dealers, Urban co-operative banks, Non- Mon to Fri
India Bonds
 banking Finance Companies and specified
All India Financial Institutions
Jan 2014 10 years NSE, BSE & MCX-SX Banks, Insurance companies, Brokerage 9AM to 5PM
Govt. of House, Primary Dealers, Mutual funds, Mon to Fri
India Bonds Provident and pension funds, Corporate
Houses, Retail individuals and FIIs
Notes: FRA- Forward Rate Agreement, IRS- Interest Rate Swaps, IRF-Interest Rate Futures.

In 2003 and 2009, this product was a failure. IRFs on 10-year

Government of India bonds were recently established in India.
However, it remains to be seen if it can gain traction in the
market may fall flat like before in the Indian market.
1.3 Motivation Statement:-

Choosing a topic for research, especially for a Assignment,

often stems from a combination of personal interest,
academic curiosity, and the relevance of the subject matter to
real world scenarios. Here’s a potential motivation statement
for selecting the topic, “Analysing the Impact of Regulatory
Changes on the Rise and Fall of Interest Rate Futures in the
Indian Derivative Market”.

The existence of an innovative financial instrument like IRFs

is in doubt for Indian derivative market. From the first day of
trading to till date the volume as well as total value reduced
sharply.

It is essential and has practical implications for learning how

regulatory interventions affect market volatility, trading
activity, and investor decisions. Policymakers, market
participants, and investors navigating India's complicated
 financial ecosystem may find the findings from this study to
be of great use. I want to give valuable knowledge that might
help in making wise judgments in the constantly evolving
world of finance by thoroughly studying these implications.

1.4 Importance of the Study :-

For a number of reasons, it is crucial to analyse how regulatory
changes affect the rise and fall of interest rate futures in the Indian
derivative market.
1. Market Stability and Predictability:
Market stability is directly impacted by regulatory changes.
Participants in the market, such as traders and investors, can forecast
market movements more accurately by being aware of the effects of
these changes on interest rate futures. Making educated judgments
and efficiently managing risks depend on this predictability.
2. Risk Management and Investor Confidence:
Risk management is crucial in a market as complicated as the
derivatives one. Regulation changes have the potential to reduce or
add new risk factors. Investors may modify their strategies to fit the
new risk environment by thoroughly studying these developments,
which will boost investor confidence and market participation.
3. Policy Advocacy and Government Decision- Making:
Research on the effects of regulatory changes provide empirical data
that is useful for promoting policy. Stakeholders can work with
regulatory bodies and politicians to advocate for reforms that improve
market efficiency, fairness, and investor protection by studying the
effects of certain legislation. Government decision-making may
become more informed as a result of this discussion.
4. Economic Stability:
Financial markets that are stable help to maintain a stable economy.
Studying the effects of regulatory changes helps to further the
overarching objective of sustainable economic growth and financial
stability.

1.5 Success And Failure of the Interest Rate Futures In

India:
In 2003, the RBI permitted trading on exchange-traded interest rate
futures on ten-year Government of India bonds. At that time, this
product was solely released by NSE. The banks were restricted from
trading in this derivative product and the methodology for
determining the futures rates for all contracts was ZCYC, which
average merchants did not understand For these reasons, the 2003 IRF
in India was unsuccessful market.
In 2009, again Indian financial market introduced the IRF of 10 years
Govt. of India Bonds on physically settled basis keeping the fact that
the interest rate futures are occupying the major role in the
international derivative market.

On 2009, RBI allowed the banks to trade on this product but there
was a liquidity problem, since the settlement was on physical basis.
That’s why the 2009, IRFs failed in Indian market. Financial experts
indicated the cause of failure was because of the faulty design of the
product.
 Time to time RBI constituted several committees for reforming the
introduction of interest rate futures and to get benefit out of that. Still
not a single time this product was successful. In January 2014, RBI
and SEBI permitted the same product with cash settlement basis and
allowed NSE, BSE and MCX-SX to introduce for trading on
exchanges.

The detailed of the success and failure of IRFs in India is presented in

the Table 2.

Success or Failure of Interest Rate Futures (IRFs) in India

YEAR Product Nature of Nature of Failure/ Success Changes Required
settlement the Product

1999 FRA and IRS Cash OTC Successfully worked. Due to the dynamic nature of
Settled Derivative Still Exchange traded gross credit exposures and
derivative required for information asymmetries and
maintaining lack of transparency of this
transparency and product, it is not able to
hedging interest rate risk hedge the risk Efficiently.
accordingly. Thus exchange traded
derivative requires to
introduce to reduce the risk
through a clearing
corporation, novation,
multilateral netting,
centralised settlement and
risk management
2003 10 year Cash Exchange Failed due to Cash Need of Banks participation,
Govt. of Settled Traded settled on a ZCYC and modification of ZCYC and
India Bonds Derivative Banks were not allowed short selling requires to allow
to take a trading position
on this instrument and
short selling was not
allowed
2009 10 year Physically Exchange Failed due to Cash Need of Banks participation,
 Govt. of Settled Traded settled on a ZCYC and modification of ZCYC and
India Bonds Derivative Banks were not allowed short selling requires to allow.
to take a trading position
on this instrument and
short selling was not
allowed.
2014 10 year Cash Exchange Yet to see how it is
Govt. of Settled Traded working. MCX-SX is
India Bonds Derivative going to introduce on
20th; NSE on 21st and ------------
BSE on 28th of January
2014.
Sources: BSE and RBI